Thursday, August 27, 2015
The Federal Reserve Board and the War for Poverty
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There has been much talk in recent years about inequality and the poor life chances of children who grow up in poverty. Even many conservative Republicans have been putting forward proposals that are ostensibly designed to give people the opportunity to raise themselves out of poverty and into the middle class and beyond.
While the usefulness of the various proposals for combatting poverty can be debated, the stated intention is increasing the income and opportunities for those at the bottom. This stands in sharp contrast to what the Federal Reserve Board seems prepared to do this fall. It plans to implement policies, specifically higher interest rates, which will reduce the income and opportunities for those at the bottom.
The story is that the Fed plans to raise interest rates, possibly beginning as early as next month, in order to slow the economy. The Fed immediately controls short-term interest rates, but raising these rates will likely also lead to increases in longer term interest rates like the interest rate people pay on car loans and mortgages. It will also mean that businesses have to pay more money on loans to finance investment and state and local government will pay higher interest rates on new bonds issued to pay for infrastructure.
The effect of raising these interests is to discourage people from buying cars and houses, companies from investing, and governments from improving and expanding infrastructure. This means less growth, fewer jobs, and higher unemployment.
The impact of this slowdown is disproportionately felt by those at the bottom. This can be seen clearly in the racial breakdown of unemployment. The unemployment rate for African Americans is consistently twice the unemployment rate for whites. In the data for July the unemployment rate for whites was 4.6 percent, for African Americans it was 9.1 percent. The unemployment rate for African American teens tends to be roughly six times the level for whites. In July it was 28.7 percent.
There is a similar story if we look at unemployment by education level. The July unemployment rate for college grads was 2.6 percent. It was 5.5 percent for those with just a high school degree. This means that if the Fed raises interest rates it is disproportionately workers at the bottom end of the income distribution who will be preventing from having jobs.
And this is not just an issue of jobs for the unemployed; the tightness of the labor market also affects the wages of the people who have jobs. In a tight labor market workers can demand higher wages from their bosses or go to another employer who will pay them more money.
This is exactly the story we saw in the late 1990s boom when even workers at the bottom of the wage ladder saw substantial wage gains. There were accounts of major chains like McDonald's offering bonuses to employees who brought in new workers. In order to keep workers, even many low-wage employers began to offer benefits like flexible work hours or on-site child care.
In principle we could get back to this sort of situation today, if the Fed allows the economy to continue to grow and for the unemployment rate to fall. As a practical matter, we likely have a long way to go before we see the tight labor markets of the late 1990s. While the unemployment rate is not much above its pre-recession level, this is largely because many workers have dropped out of the labor force.
While some of the drop off in labor force participation is due to the aging of the baby boomers, the employment rate of prime age workers (ages 25-54) is still down by 3.0 percentage points from pre-recession levels. This implies a gap of roughly 3 million jobs. (The drop is 4.0 percentage points if the comparison is with the 2000 peak.)
These numbers indicate that we have a long way to go before the labor market is strong enough so that workers at the middle and bottom of the wage distribution have enough bargaining power to share in the gains of growth. However if the Fed raises interest rates too rapidly, the labor market may never reach that point.
Of course the Fed is not acting out of maliciousness. Its concern is that if it allows the current rate of job creation to continue we will see inflation. Many of us see the worry over inflation as very wrong-headed, given the lack of inflationary pressures anywhere in the economy.
However it is important that the public have a clear idea of what is at stake in the Fed’s decisions on interest rates. While many politicians and policy experts are grappling with ways to try to lower the poverty rate, by raising interest rates, the Fed will be directly preventing people in poverty from getting jobs and seeing pay increases. We can argue over the best policies to get people out of poverty, but a good place to start would be to end policies that keep them in poverty.